The stock market is up over 14% since the election, and more aggressive investors have been well rewarded for taking the risk. At the same time, very cautious or skeptical investors may have actually seen slight declines in their investments over this same period of time.

This is primarily due to a fairly substantial increase in longer term interest rates since the election.

For example, the yield on a 10 year U.S. Government bond has gone from approximately 1.4% to over 2.4%, a 70% increase!

The significance of this is that as interest rates rise, many bond values tend to drop. So investors whose portfolios were predominantly allocated in bonds, not only missed the stock market rally, but may have actually taken a small step backwards.

This brings up several questions:
Are interest rates likely to continue to go up?
If so, what impact may this have on bonds?
What are strategies that may work for investors who wish
to remain cautious?

Let’s address the interest rate outlook first. Most economists feel that over the next few years interest rates will more than likely increase. The real issue is how high and how fast. A very sudden increase in rates could have a much bigger negative impact on bond values. A rising interest rate scenario would not affect all bonds the same way. Shorter term or variable rate bonds could hold up much better than longer term ones. The reason is simple, the longer the period before the bond matures, the more risk you are taking that interest rates may continue to rise while you own that bond.

Investor Dilemma
So here’s the cautious investors’ dilemma: Because Interest rates are near historic lows, the temptation is to buy longer term bonds in an attempt to increase investment income. By doing this though, the value of those bonds may drop significantly if interest rates continue to increase, especially if they were to spike quickly.

Investor Solution
One popular strategy to address this dilemma is to “ladder” the maturities of the bonds. Instead of buying a single bond for $50,000 with a single interest rate and maturity, you could buy several bonds with differing maturity dates and yields.

For example, you could buy one $10,000 bond that would mature in one year, a second one that would mature in two years, a third at three years and so forth. Each bond would represent a different rung on the ladder. By staggering the maturities you are reducing the risk of rising interest rates, since you have the opportunity to annually reinvest the maturing bonds at the then higher interest rates. While this technique would slightly reduce the interest rate you could earn than if you would have bought a single longer term bond, it would also give you some protection if interest rates were to dramatically rise and you needed to sell the bond before it matured.

In addition, investors can customize their portfolio’s by adjusting the “height” of their ladders (the length of the longest term bonds), the duration difference between each “rung”, and the types of bonds being bought ( government bonds, tax-free bonds, corporate bonds, etc.).

Conclusion
Bond laddering is not for everyone. Most professionals agree that a bond ladder shouldn’t be attempted if investors do not have enough money to fully diversify their portfolio by investing in several types and durations of bonds. The money required to properly diversify a bond ladder that would have at least five rungs would typically be over $150,000. If you don’t have this recommended amount, purchasing products such as bond funds or ETF’s might be more prudent.

In either case, it’s important to work with a professional to make sure that all your eggs aren’t in one basket, so that you can control risk exposure, have greater access to emergency funds and have the opportunity to capitalize on ever-changing market conditions.

If you have questions in regard to using a bond ladder strategy, feel free to give us a call.

Les Szarka, CFP®, ChFC®

Les Szarka is Chief Executive Officer, founder and co-owner of Szarka Financial. He has been a financial advisor and retirement planning specialist for over 30 years. Les builds deep relationships with his clients and has a profound commitment to help them reach their financial goals and objectives.

In our book, Money Talks: Life Lessons to Help You Plan Now, Save Wisely, and Retire Well, you’ll find many stories of people from all walks of life as they navigate the different stages of life. These stories will help illustrate key aspects of financial planning, showing you what to do—and what not to do—as you go through life.

Due to various state regulations and registration requirements concerning the dissemination of information regarding investment products and services, we are currently required to limit access of the following pages to individuals residing in states where we are currently registered. A broker/dealer, investment advisor, BD agent or IA rep may only transact business in a particular state after licensure or satisfying qualifications requirements of that state, or only if they are excluded or exempted from the states broker/dealer, investment adviser, or BD agent or IA rep requirements, as the case may be; and follow-up, individualized responses to consumers in a particular state by broker/dealer, investment adviser, BD agent or IA rep that involve either the effecting or attempting to effect transactions in securities or the rendering of personalized investment advice for compensation, as the case may be, shall not be made without first complying with the states broker/dealer, investment adviser, BD agent or IA rep requirements, or pursuant to an applicable state exemption or exclusion. Investments products and services available only to residents of : Arizona (AZ), California (CA), Connecticut (CT), District of Columbia (DC), Florida (FL), Georgia (GA), Illinois (IL), Indiana (IN), Kentucky (KY), Massachusetts (MA), Maryland (MD), Michigan (MI), Minnesota (MN), North Carolina (NC), New Jersey (NJ), New Mexico (NM), New York (NY), Ohio (OH), Oregon (OR), Pennsylvania (PA), South Carolina (SC), Tennessee (TN), Texas (TX), Virginia (VA), Washington (WA) *Securities offered through Registered Representatives of Cambridge Investment Research, Inc., a Broker Dealer, member FINRA/SIPC. Advisory Services through Cambridge Investment Research Advisors, Inc., a Registered Investment Adviser. Cambridge does not offer tax advice. PLEASE NOTE: The information being provided is strictly as a courtesy. When you link to any of the web sites provided here, you are leaving this web site. We make no representation as to the completeness or accuracy of information provided at these web sites. Nor is the company liable for any direct or indirect technical or system issues or any consequences arising out of your access to or your use of third-party technologies, web sites, information and programs made available through this web site. When you access one of these web sites, you are leaving our web site and assume total responsibility and risk for your use of the web sites you are linking to. These links are provided as a convenience and for informational purposes only. The links are not part of Cambridge’s website, and the link to outside websites does not mean that Cambridge endorses or accepts any responsibility for the content, or the use, of the web site. Cambridge does not guarantee the sequence, accuracy or completeness of the data or other information appearing on the linked pages. The company assumes no liability for any inaccuracies, errors or omissions in or from any data or other information provided on the pages, or for any actions taken in reliance on any such data or information.